The majority of adults in the UK have, at some point, taken out credit. Whether it’s for a mortgage, in the form of car finance or even simply a credit card for emergency purposes, most people will be familiar with the different types of credit available. What can sometimes confuse people, however, is the difference between good debt and bad debt, and how the different types of credit you apply for and use can affect your credit file in different ways.
Simply, debt is when a person or a company owes another person or institution money. Even borrowing a fiver from a friend could be considered a debt, although without an agreement in writing that you will pay the friend back, it would be hard to prove in the court of law that you owed them any money. For the sake of this article, we will discuss the different types of debt associated with consumer credit agreements. This covers nearly all regulated agreements between businesses and consumers.
Good debt is still debt, but it’s considered more like a financial investment, which will reap higher rewards than if you hadn’t taken the debt in the first place. For example, a mortgage is considered good debt, because although you may owe a bank £100,000, over time, you repay that debt and gain a large financial asset. Additionally, as houses tend to increase in value, your £100,000 in 2005 might be worth £130,000 in 2020, so your debt actually made you money. Because you are obtaining a financial asset which might be worth more than what you paid for it, a mortgage is considered a good debt.
Bad debt, on the other hand, is credit which is not an investment and doesn’t bring any financial benefits. Bad debt can include:
Essentially, a bad debt is any debt which costs you more money than it offers to return in the first place. Although sometimes it’s impossible not to obtain bad debt, as long as you are able to manage the repayments, there’s no real harm in using a credit card or taking out a payday loan to cover emergency expenses. However, if you start to see a build up of debt, and your current financial circumstances are making it increasingly difficult to maintain your repayments, you may want to consider asking for help.
While repaying a debt late is not good, it’s not always advisable to repay a debt early. Some institutions will charge early repayment fees, and some debts, such as a student loan, are so large that the likelihood of repaying your student loan in full is so small, that it would be like throwing money out of a window.
If the loan is slightly smaller, such as borrowing on a credit card, then you should always aim to repay the debt as soon as you can afford to do so. While you might need to make only the minimum payment in some months, where you can, you should aim to repay the balance in full. This way, you reduce the total amount of interest being charged for your borrowing, and you free up credit that you might need in the future which means you won’t have to take out additional credit elsewhere.
We aren’t an authorised debt advice service, so unfortunately, we can’t give you explicit advice on how to handle your debts. However, we can suggest you get in touch with a free debt advice service such as StepChange or National Debtline.
StepChange is a debt management charity and they can help you set up a free debt management plan which helps you organise your debts; you make one repayment to them and they will split the payment pro-rata amongst your creditors. The benefit of using a charity rather than a debt management company is that the service is free, so you won’t be charged for arranging a DMP with StepChange as opposed to other providers, which means all of your monthly repayment goes towards reducing your debts.
National Debtline won’t set up a debt management plan for you, but they will help you understand the different types of debt, draw up a budget sheet and work out a payment schedule – they will also contact your creditors and make the whole process of arranging multiple repayments plans much more simple.
Debt can seem like a daunting prospect, but in reality, most people use credit on a daily basis. As long as you can meet your financial commitments each month, taking out credit can be a way to manage your finances. If however, you start to feel your debts are getting out of hand – whether good debt or bad debt – it’s better to tackle the problem head on and seek professional advice, as missing your repayments can cause you serious money problems and make credit harder to obtain in the future.
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